What happened
Shares of high-yielding real estate investment trusts (REITs) Medical Properties Trust (MPW -1.10%) and Brandywine Realty Trust (BDN 1.59%), along with renewable energy company NextEra Energy Partners (NEP -0.89%), sank on Tuesday, down 4.4%, 6.7%, and 8.3%, respectively, as of 12:20 p.m. ET.
At first, these stocks don't seem to have much in common. Medical Properties Trust owns hospitals and leases them out on a global basis. Brandywine owns office, residential, life sciences, and transportation-related properties. And NextEra Partners buys renewable energy assets from its parent company NextEra Energy (NEE -1.36%) and manages them.
But they each pay out high dividend yields, and their balance sheets are highly leveraged. That's not a great combination if there is a rapid move upward in government bond yields, against which many debt and equity prices are set. And that is exactly what's happening this week, with another catalyst on Tuesday morning.
So what
Today, long-term bond yields, as exemplified by the 10-year Treasury bond, continued their rise, with the 10-year reaching a 17-year high of 4.79%. It has been a somewhat stunning rise for government bond yields. Just one month ago, the 10-year yield was in the 4.2% range; and six months ago, in the aftermath of the regional banking crisis, it was down in the 3.2% range.
Long-term government yields could be going up for either good or bad reasons. It would be bad if investors were losing faith in the government's ability to pay its bills, and they were therefore demanding higher rates.
But more likely, the recent rise is likely due to strength in the economy and investors coming around to believe there will be strong economic growth and inflationary pressures instead of a near-term recession.
Fortunately, the second reason appears to be the case. This morning, the Job Openings and Labor Turnover Summary (JOLTS) report came out, showing a sizable increase in the number of job openings: 9.61 million at the end of August, above July's 8.91 million (which was also upwardly revised) and higher than the consensus estimate from economists of 8.8 million.
As job openings continue to be above the number of unemployed people, the strong number we got today is thought to be a harbinger of continued inflation, which the Federal Reserve is trying to tamp down. Thus, investors might be repricing these three stocks in anticipation of more interest rate hikes, whereas many had thought the Fed might be done.
This is all quite bad for bonds, whose prices move in the opposite direction of yields, as well as bond-like stocks. This includes REITs, MLPs, and power-producing yieldcos such as these three companies.
But rate moves are actually doubly bad for these types of equities. Not only do higher "risk-free" government yields lower the price investors are willing to pay for these three companies' payouts, but these companies also typically use lots of debt to purchase real assets. Therefore, when rates go up, it can lead to an inability to finance new purchases, while increasing their cost of refinancing existing debt.
In fact, these stocks have already seen the effects of the rate increases in recent weeks. Medical Properties Trust had to slash its dividend nearly in half at the end of August, and it recently sold properties in Australia to deal with near-term debt maturities.
Meanwhile, NextEra Energy Partners announced last week it would lower its dividend growth outlook from a range of 12% to 15% annually to just 5% to 8%, in light of higher financing costs.
Long-term bond yields continue to skyrocket. Image source: Getty Images.
Now what
Investors often look at bonds and high-yielding REITs and MLPs as somewhat low-risk yield instruments. But they would also do well to understand the risks. If interest rates move strongly higher, that can affect the price of all yielding assets -- even so-called "risk-free" bonds such as long-term U.S. Treasuries that are backed by the government.
For instance, if you had invested in 30-year Treasuries when interest rates were at their low during the pandemic, you would be sitting on massive losses, which you might not recoup until maturity.
The only way the three companies mentioned above can do well in this environment is if they can continue to raise rents at a strong pace to keep up with the rise in financing costs.
However, power-producing assets are usually under fixed or capped rates for long periods. Hospitals have been struggling with labor costs due to nursing shortages, and likely couldn't afford a huge rent increase. And office properties for Brandywine are probably under pressure from work-from-home trends.
Therefore, it's no surprise to see these companies struggling as rates have rocketed higher.